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India Needs Skill to Solve the "Bangalore Bug" A Commentary by Raghuram Rajan, Economic Counselor and Director, and Arvind Subramanian, Chief of the Macroeconomic Studies Division in the Research Department, IMF

The market for skilled labour is scorching hot in India. A McKinsey report indicates that wages for project managers have risen by a compound annual growth rate of 23 percent since 2000 (albeit from a low level). These are indeed the wages of success. But should India worry?

Rising wages reflect, in no small measure, productivity increases as Indian manufacturing and services become globally competitive. Short-term concerns about inflation are thus mitigated. But the wage increases also reflect India's unique pattern of development, which has created a relative scarcity of skilled labour. This prompts concerns about the medium term: the rising fortunes of the skilled sector may limit the vitality of industries that employ the unskilled and uneducated. It is a conundrum that one might term the "Bangalore bug", after the country's high-technology centre.

Since the 1980s, a unitary India—centralised politically and uniformly mediocre in economic performance—has given way to multiple Indias with performance more related to the capabilities of individual states. Peninsular India, including states such as Karnataka, Maharashtra, Gujarat and Tamil Nadu, has grown rapidly. The hinterland, with states such as Uttar Pradesh, Bihar, Madhya Pradesh and Rajasthan, has lagged behind.

The divergence relates not just to growth but to patterns of specialisation. Policy choices emphasising university education over basic education and capital-intensive manufacturing over labour-intensive manufacturing have bequeathed a strange legacy. The fast-growing states are increasingly specialising in skill-based services (information technology, finance and telecommunications) and skill-based manufacturing (petrochemicals and pharmaceuticals).

A big question is how the lagging states, with their large populations and attendant political power, can catch up. India's primary and secondary education system, as well as its labour laws, need serious attention if the benefits of the recent dynamism are to be widely shared. Reforms in these areas, along with improvements in governance and infrastructure, are necessary to attract investment and create jobs.

However, even if all these reforms—on the need for which there is consensus among Indian policy economists, although not politicians—are implemented, there is another concern. Recall Dutch disease, which is about the competitive squeeze exerted on one tradeable sector (manufacturing) as a result of wage increases stemming from the rising fortunes of another (typically oil). The Bangalore bug is the contemporary Indian variant, with skill-based services substituting for oil.

Textile plants need supervisors. Bicycle factories need designers. They both require managers. Yet these are the very people whose wages are being bid up sharply, squeezing the profitability of labour-intensive and tradeable manufacturing, with its wafer-thin profit margins in an era of global competition. Thus, highly productive skill-based development in the fast-growing states, while beneficial for the nation, may indirectly undermine the profitability and growth of labour-intensive manufacturing in the others. Moreover, the rise in skilled wages also leads to an exodus of scarce skilled labour from the states lagging behind to the fast-growing ones.

What is the remedy? The obvious solution is not to impede the growth of the fast movers but to enhance the availability of the resource in scarce supply. The strong growth in particular sectors requires India to continue to foster the supply of skilled labour, even while redressing the past neglect of primary and secondary education.

Fortunately, tertiary education does not require more government resources. Instead, the government needs to remove the barriers that prevent foreigners and locals from starting new institutions, while improving accreditation procedures and disclosure standards. It should not encumber private institutions with onerous conditions and it should allow government-aided institutions to raise resources by charging students a reasonable fee. This means overcoming a number of vested interests.

The irony of the Bangalore bug is that to create opportunities to benefit the poor and the unskilled, India may in fact have to produce more skilled workers.